“Working for a non-profit organization, I have the option of contributing to a 403(b) plan, but what is a 403(b) plan, and is it worth my investment?”
A 403(b) plan is a tax-deferred retirement option, similar to a 401k, commonly available to those working in the non-profit sector. Providing a myriad of financial benefits – including tax deferral/tax exclusion, potential company matching, and the flexibility to adjust your contributions and allocations to match your investment strategy – a 403(b) can serve as a solid pillar toward a stress-free retirement.
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Who Can Contribute to a 403(b) Plan?
If you are a full-time employee for a non-profit organization, check with your HR department to see if they offer a 403(b) plan. 403(b) plans are most common among public schools and employees of the church. If your employer offers a 403(b) plan, it must offer it to all eligible employees but can require a minimum annual contribution of up to $200.
How Much Can You Contribute to a 403(b) Plan?
The annual contribution limit for a 403(b) plan is currently $20,500. If your employer offers a match, their contributions cannot exceed an additional $37,500. This combined total cannot exceed your earned income for the year. If you contribute to both a 403b and 401k, your cumulative contributions to both plans cannot exceed these limits. We reviewed current contribution limits via IRS public information.
Similar to an IRA, catch-up provisions may exist for employees who have worked for a company for fifteen years or more and contributed less than the maximum in prior years. This allowance is up to the employer and can allow qualified employees to contribute an additional $3000 a year. More common is a catch-up provision of $6,500 a year for those 65 years of age or older.
When Can I Enroll in a 403(b) Plan?
Enrollment windows may vary by employer but should become available upon your start date at the company. Ideally, your HR team would provide you with this information during orientation. Regardless, it is always worth your time to check out your company’s benefits website to familiarize yourself with your options.
You likely can enroll, cancel, or adjust your contributions, at any time, through your HR department.
You commonly can change your investment elections by logging in to your online account with your 403(b) vendor. Depending on the time you submit changes, they may not take effect for in-progress contributions.
How Do I Enroll in a 403(b) Plan?
Qualified employees can contribute to a 403(b) by enrolling through one of their company’s approved vendors. Reach out to your HR department or review your benefits website for information on the enrollment process.
You will sign an agreement with your employer to redirect either pre-tax (most common) or post-tax (if your employer offers a Roth option) from your paycheck and send it to your selected vendor.
Once your selected vendor has established your account, sign in and choose the funds you want your contributions to be invested in. Taking the initiative to review your options and direct your investments is vital! The default options are likely to be overly conservative or carry higher fees and lower your returns in the long run.
Can My Employer Automatically Enroll Me in a 403(b)?
Employers may enroll new employees into a 403(b) account automatically, but it is more common for the plan to be optional and enrollment to fall to the employee. Check with your HR Department to confirm; if participation is automatic, your employer should inform you upon hire and provide you the option to elect out.
Does My Employer Have to Match My 403(b) Contributions?
Employers do not have to match employee contributions. 403(b) matches are less common than 401(k) matching programs. Current rules may even incentivize employers not to match employee contributions. Once employers offer an employer match, the plan falls under the Employee Retirement Income Security Act of 1974 guidelines. ERISA guidelines establish standards that retirement accounts must meet, and adhering to them can be slightly more expensive for the employer.
What Can I Use the Money in My 403(b) For?
Distributions from a 403(b) plan are subject to many of the same guidelines as those from a 401(k). To avoid immediate taxes/penalties/fees or a ten percent penalty (for qualified hardship distributions), individuals must reach the age of 59.5 before taking money out of the account. Upon reaching that age, the account balance belongs to you, and you can use it as you see fit.
If you leave your job, regardless of if it was initiated by yourself or your employer, after the age of 55, you can withdraw money without penalty. Additional exceptions exist for extreme medical expenses, certain disasters, or the addition of new children into your family, among less common situations.
If your employer offers a Roth 403(b) plan, you can withdraw contributions at any point without penalty once your account is five years old. Earnings, however, will be subject to a ten percent penalty until you hit the age of 59.5.
What Are the Tax Advantages of a 403(b) Plan?
The majority of 403(b) plans require you to make contributions from your paycheck before taxes. These pre-tax contributions allow you to contribute more while lowering your current tax bill. Taxes on all of your earnings are similarly deferred until distributed, allowing them to compound more quickly through your working years.
If your company offers a Roth component to their 403b plan, you will contribute post-tax dollars, but all of your gains through the life of your plan will be tax free.
What are some pros and cons of 403b?
Cons:
- Lack of Diversity– Investment options may be more limited in a 403(b) plan.
- Offerings tend to skew fairly conservative, with age target funds and annuities commonly being default selections.
- Recent years have brought about a legislative interest in modernizing 403b plans to expand the investments offered and lower fees.
- Less Structured – than a 401(k)- Many 403(b) plans are not protected by ERISA
- Plans with an employer match automatically fall under ERISA
- Fees Eat Into Your Retirement– low quality vendors, offering high fee options are more common than they should be
- The quality of plans, and the products they offer, are getting better.
Pros:
- Automatic– Once enrolled, your contributions will be made to your account each pay period.
- Tax Deferral-If you expect the value of taxes paid in the future to be less that your current taxes, then lowering your income now can allow additional funds to grow until you need them.
- High Contribution Limits-With annual contributions up to $20,500 you can lower your taxable income far more than an IRA
- Flexible– On a federal level, contributions can be increased or decreased throughout the year. As with other tax-deferred accounts, you can adjust or rebalance holdings to align with your life and investment strategy.
Should I Contribute to a 403(b)?
403(b) plans can be a powerful tax advantaged tool in saving for your retirement, but depending upon your situation, there may be better options available. Consideration of the following can help determine if a 403(b) plan is right for you:
Quality of Vendors and Associated Fees
The quality of 403(b) plans varies dramatically from vendor to vendor, making it vital that you review all of your options. Contact each contracted vendor and ask them to provide you with a list of investments their plan offers and the fees they charge. In the early days, these approved vendors mostly consisted of insurance groups offering high fee annuities, but good plans now include well-known investment brokers offering much more diverse options. Well-respected vendors, including Vanguard and Fidelity, are common options, likely to have solid offerings with low fees.
Company Match
If your employer offers a match and partners with at least one vendor offering low-cost funds, it is likely worth your while to contribute, at least to the maximum match amount. Employer matches are a rare case of virtually free money, and by offering a match, the plan now falls under ERISA protections. If your employer contributes no match, your first $6,000 each year may be better served in a Traditional/Roth IRA. If you are in a place where you can afford to contribute to both, a 403(b) will allow you to invest up to an additional $13,500 each year.
Active vs Passive
If you tend to actively manage your account, adjusting your holdings throughout the years, tax deferral may be slightly more valuable than someone who will select a broad-based fund and leave it to grow. These transactions would not be taxable events within your 403(b) allowing your full account balance to carry through to the new investments.
Time Horizon
It strikes me as counterintuitive that the value of tax deferral would drop over a longer time horizon. Over time, more and more of the value of the account is comprised of accumulation, not the initial investment. As the value of your account increases, even a modest percentage fee hurts more and more. Over a few years, modest fees may not outweigh the money saved via tax deferral, but at a certain point, they have been applied enough times to erode this benefit significantly.
Tax Bracket
Tax deferral is most valuable when you expect to pay lower taxes while withdrawing money from your account than in the years you spend funding it. If you find yourself in a low tax bracket and expect to increase your income heading into retirement, you may find it in your interest to pay the income tax now.
My situation is a bit of a mixed bag. I am fortunate in that my employer partners with a couple of solid vendors who offer a robust lineup of low-fee stock funds. Among both vendors’ offerings is an S&P500 index fund I have already begun to invest in through my standard brokerage as I look to create a better balance between individual stocks and index funds.
On the other hand, like many, my employer does not offer any match. I do not expect to actively trade out of this fund forgoing one of the advantages of a tax deferred account. I am 37, so I have a fairly long time horizon. Finally, I am currently in a low(er) tax bracket and would expect to be around the same (or higher) in retirement.
Running the numbers, under the above considerations and assumptions, showed that the account fees would outweigh the benefits of tax deferral. I called upon a Director of Accounting for a local non-profit to validate my findings. In my case, I am likely better off investing in a standard brokerage account, but could a 403b make sense for you?
Absolutely! I think a 403(b) plan can fit within a portfolio if:
- Your Employer partners with reputable vendors who offer a range of solid funds.
- If the only options available are annuity-based with high fees, it’s a tough sell. If the only options are age-based funds, you most likely have better options elsewhere.
- You are in a high tax bracket now.
- Tax deferral may be at a premium for you, and the high contribution limit of a 403b plan can appreciably reduce your current tax burden.
- You have no interest in investing this money on your own
- While a poor plan is likely never worth investing in, even a mediocre plan can be a dramatic boost to your retirement when weighted against not investing that money at all.